Question

The income statement provides accrual based earnings and the cash flow statement provides cash flows from operations. Which of these measures of firm performance is more important to investors, auditors, and fraud investigators? Is it possible that one of these measures can provide clues about manipulation of the other? What are some red flags that could signal manipulation of income from operations or cash flows from operating activities?  

Answer 1

Solution :

The income statement is the most important measure that indicates performance measure.

Since income statement reveals about the company's financial performance, the investors, auditors and stakeholders should look for red flags, that indicate that the financial statements are manipulated.

The following are the signals or red flags that indicate a possibility of manipulation or fraud :

1) Inconsistent growth in revenue or sudden increase in revenue as compared to previous quarter or years.

2) Inconsistent change in expenses as compared to previous years without any proper explanations in the notes.

3) Huge gain or loss occuring from non-recurring transactions.

4) Increasing accounts receivables without any cash inflow from them or a very little cash inflow from debtors.

5) Frequent changes in accounting policies

6) Unrealised other Income gains or unexpended loses.